Why We Cannot Afford The Republican Budget

Early this morning, the Senate approved a Republican-authored budget that features deep cuts in spending, no new taxes, and hopes of a balanced budget within the next decade. However, not only could their plan never achieve what they hope, it would be an absolute economic catastrophe. Let’s hope it never sees the light of day.

The level of ignorance regarding federal government budgeting is horrifying. I don’t just mean among lay people or the general public, but right up the both houses of Congress and the White House-–you know, the people who actually make the decisions. Nor is it limited to one party. While the Republicans have been far more rabid about it, the Democrats, too, are anxious to see the day when the budget deficit is not only smaller, but eliminated entirely. Best of all, they say, we might even reach the point of having surpluses that can cut into our massive national debt. While they may prioritize these goals differently, it appears that just about every single politician in Washington shares these sentiments.

God help us.

First off, it is impossible for the United States to be forced to default on the national debt. Not improbable, not unlikely, but impossible. This isn’t an opinion, it’s a cold, hard fact. The reason is that one-hundred percent of the debt is in United States of America dollars, something we and only we are allowed to print. But don’t take my word for it, listen to these prominent scholars and analysts:

“As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational.” Federal Reserve Bank of St. Louis

“In the case of United States, default is absolutely impossible. All U.S. government debt is denominated in U.S. dollar assets.” Peter Zeihan, Vice President of Analysis for STRATFOR

“In the case of governments boasting monetary sovereignty and debt denominated in its own currency, like the United States (but also Japan and the UK), it is technically impossible to fall into debt default.” Erwan Mahe, European asset allocation and options strategies adviser

“There is never a risk of default for a sovereign nation that issues its own free-floating currency and where its debts are denominated in that currency.” Mike Norman, Chief Economist for John Thomas Financial

“There is no inherent limit on federal expenses and therefore on federal spending…When the U.S. government decides to spend fiat money, it adds to its banking reserve system and when it taxes or borrows (issues Treasury securities) it drains reserves from its banking system. These reserve operations are done solely to maintain the target Federal Funds rate.” Monty Agarwal , managing partner and chief investment officer of MA Managed Futures Fund

“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” Alan Greenspan

“A sovereign government can always make payments as they come due by crediting bank accounts — something recognized by Chairman Ben Bernanke when he said the Fed spends by marking up the size of the reserve accounts of banks.” L. Randall Wray, Professor of Economics at the University of Missouri-Kansas City and a Senior Scholar at the Levy Economics Institute

Default should be completely off the table as a possibility. Anyone who actually understands how the economy actually works would never mention it.

But there’s more. Think about this: if the United States has a trade deficit of $2.8 billion with Canada (January’s numbers), then what does Canada have with the US? Obviously, a trade surplus of $2.8 billion. Now substitute “federal government” for “United States” and “private sector” for “Canada” and you get a critical truth: the federal government’s deficit is, by definition, the private sector’s surplus. If the government is spending more than it earns, then the non-government sectors are earning more than they spend. This is an inescapable truth of what is actually a very simple accounting identity. It appears to be lost on Washington, however.

Therefore, if we adopt a budget that aims at lowering or even eliminating the deficit, we are simultaneously adopting a budget that reduces or eliminates the private sector’s savings. And it doesn’t matter how we do it, whether by raising taxes or cutting spending. Either one takes money out of someone’s pocket and there is no question that economic contraction would result. The greatest irony is that, in that event, the consequent reduction in tax revenue and increase in unemployment compensation payments would make the deficit larger!

This is not to say that we should just spend, spend, spend. While default could never be a possibility, inflation could be. Once the economy is at full employment, further stimulation of spending will simply drive prices up. This is why during World War Two we had rationing and wage and price controls. Despite unemployment rates as low as 1.9%, the government continued to run massive deficits (for obvious reasons). Consumer goods were in short supply but incomes were high–a recipe for inflation. Right now, however, we stand at 5.5%, well out of range of the point where we should worry about how much we are spending. In fact, we need to spend more. Examine these numbers from our recovery thus far:

Avg GDP Growth When Govt Spending Increased: 3.37%

Avg GDP Growth When Govt Spending Decreased: 1.90%

Quarters when government spending increased witnessed growth rates almost double of those when it did not. Of course they did. Government spending isn’t money thrown into a sinkhole, it goes into the pockets of businesses and households. It’s the paycheck of a soldier, the Social Security check of a grandmother, the Medicare payment made to a doctor’s office, the grant money that finances a research project, and so on. And whether we raise taxes or cut spending, the outcome is the same: lower incomes, lower spending, and lower growth. We cannot let this happen.

It’s ironic that the Republicans have made such noise of late regarding the fact that the unemployment numbers make the recovery appear more robust than it really is while at the same time proposing a budget that will hit those “uncounted Americans” the hardest. Let’s hope that they don’t get their way and that both parties wake up to what they are really doing. The budget the Republicans are proposing is one that we cannot afford.